image credit: Gazprom
image credit: Gazprom

Will the ‘Power of Siberia’ Take Off?

In May 2014 Russia signed a major 30 year, 38bcm per annum gas deal with China deliverable from 2018. Whilst there have been questions as to price of the gas (estimated at $300 per thousand cubic metres) the two real questions are firstly can Russia really deliver on the deal and secondly, what impact will the deal have on the Chinese gas market? If Russia can deliver on the deal on time and at a price which makes commercial sense it will open up a significant new gas market for Gazprom. For China the deal could help further supply diversification from Western and Gulf based LNG gas sources.

Gazprom has clearly not been standing still since the May agreement. Already the first pipes for the “Power of Siberia” GTS pipeline have been delivered to Lensk (Yakutia).The first first delivery consists of 260 pipes with a 1420 mm diameter and total weight of 2.4 thousand tons. These pipes will be used for the trunkline construction from the Chayandinskoye field in Eastern Siberia. In 2014 Gazprom plans to provide more than 120 thousand tons of pipeline. By 2018 the number will increase to 1700 thousand tonnes.

The first section of the Power of Siberia GTS – the Yakutia – Khabarovsk – Vladivostok gas trunkline – will come onstream in late 2017. That will let Russia reach China’s northeast regions and start direct gas sales in 2018.

For Russia, the eastern deal became the biggest in history of Gazprom. Alexey Miller, Chairman of the Gazprom Management Committee, said: “We opened a brand new market with a huge potential for the Russian gas. The arrangement of Russian pipeline gas supplies is the biggest investment project on a global scale. An extensive gas infrastructure network will be set up in Russia's East, which will drive the local economy forward. Great impetus will be given to entire economic sectors, namely metallurgy, pipe and machine building”.

Moreover, this deal is a strategic move for Russia indicating to the West that Russia has alternatives to supplying the stagnant European gas market. Annexation of Crimea followed by Western sanctions changed the situation in the world: Russia becomes more isolated, Europe tries to find alternatives to natural gas supplies from Russia, the U.S. attempt to help wean Europe off Russian energy by gradually lifting its ban on  gas exports. In these circumstances, Russian turn to Asia is predictable.  The major query amongst analysts has been the pricing of the gas in the deal. The exact price of natural gas for China remains a “commercial secret”, European and Russian analysts say it is about $350 per thousand cubic meters of gas, while Chinese analysts, including energy expert Xun Yunsan from Development Research Center of the State Council, think is $380-388 per thousand cubic meters. Analysts also cannot agree on commercial viability of the deal. According to UBS, the “Power of Siberia” would be profitable only with a price around $570 per thousand cubic meters, whereas Merrill Lynch analysts believe the range of $340-360 is enough to repay capital cost and actually generate revenues. One major factor in the glaringly different price-at-profitability projections is the difficulty of estimating the costs of construction through the Russian Far East.

However, what is not recognized in the debate amongst many of the analysts is that the determination of Gazprom to find alternative outlets for its natural gas resources and the falling cost for Gazprom once the first pipeline is built. Much of the Russian Far East construction will require costly new infrastructure, roads, support services, bridges and power lines. Once built the cost of additional pipelines will fall making expansion of pipeline capacity much more profitable. 

From a Chinese perspective, the deal offers the opportunity of improving the country’s ecological situation and reduction of energy shortages. China is extremely dependent on coal. According to the U.S. Energy Information Administration report, coal provides 69.5 percent of the China’s energy consumption. In some regions, like Manchuria, this rate is much higher. As a result, the country became sadly famous for its “airpocalypse” and a critical situation with diseases caused by coal dust. Another way to underline this issue is to point to the report by the Chinese Academy of Sciences which estimated that 1.2 million Chinese die every year from coal related respiratory diseases. The health and ecological issues provide compelling reasons to use more gas and less coal. 

It is not surprising therefore that energy supply was a major priority at the 18th National Congress of the Chinese Communist Party. Currently, Central Asia is supplying nearly half of China’s imported gas. However, even with the increased imports from Turkmenistan (that is aiming at providing 65 billion cubic meters annually), China still needs more gas. The difficulty for China is that shale gas development will take time and the only other importer options are to rely on gas from Western countries such as Australia and Canada or from Indonesia and Qatar. For China there is a significant energy security question as over-reliance on gas imported as LNG by sea essentially forces China to be reliant on gas being delivered by grace of control of the sea by the US Navy. For China, whilst additional LNG supplies are welcome over-reliance is unacceptable. The China-Russia deal opens up the prospect of taking more gas from Russia offsetting the risks of taking gas coming by sea whilst giving China more time to deliver a significant level of domestic shale gas supply in the late 2020s or early 2030s.

The conditions for a great China/Russia gas deal are in place whether they will be fully developed depends on a host of geographic, political and economic factors. However, it would be wrong to instantly dismiss this deal as a far-fetched, under-priced,one-off political deal. It may work, and if it works it could have significant economic and political effect.

Marina Zvonareva is a Natural Gas Europe analyst focused on Russia’s international energy relations 

 

 

 

 

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